Playing a China Sentiment Change in Metals

by Tyler Craig | September 10, 2012 11:46 am

Playing a China Sentiment Change in Metals

The price action in China lately can be appropriately characterized as a one-sided bearish affair. For the past four months, the Dow Jones Shanghai Index (DJSH) has sunk to new lows virtually every week. On Friday, however, the bulls issued a shot across the bow, lifting the beleaguered benchmarke an impressive 4.3%.

Given China’s healthy appetite for copper, steel, aluminum and other metals, the entire basic materials complex via the Materials Select Sector SPDR ETF (NYSE:XLB[1]) lifted 2% on the day as well. In fact, with Friday’s rise, the basic material space rose atop the sector performance leaderboard, boasting the best return of the week.

One group within the basic material sector I’m eying with increased interest is the SPDR S&P Metals and Mining ETF (NYSE:XME[2]). After lying dormant for the past four months and drastically underperforming the broader market, XME staged a high-volume breakout on Friday and appears poised to continue higher.

With a price tag in the low $40s and option contracts listed in $1 increments, XME is a prime candidate for selling puts. What’s more, its options are super-liquid with bid-ask spreads a few pennies wide.

Click to EnlargeTraders willing to bet XME remains above $41 for the next six weeks could sell the October 41 put for 70 cents or better. The max reward is limited to the $70 (70 cents x 100) received at trade entry. By selling the put, traders obligate themselves to buy shares of XME if it sits beneath $41 at October expiration.

To manage risk, traders might consider closing the position if XME falls beneath recent support at $40.